Question

Suppose the business cycle in the United States is best described by RBC theory and that an advance in technology increases productivity. Show the effect of the new technology in the labour market. Draw a demand curve for labour. Label it LD- Draw a supply curve of labour. Label it LS, Draw a point at the equilibrium quantity of labour and real wage rate. Draw two new curves that show the effect of the increase in productivity. Label the curves. Draw a point at the new equilibrium quantity of labour and real wage rate.

Answer 1

Assuming that the United States is best described by the real business cycle theory that explains that the economic factors fluctuate due to real shock in the economy.

Given that, there is advancement in the technology that increases the productivity level in the economy.

The given graph shows the initial labor demand curve, supply curve, and equilibrium point at e0. Let say, initially equilibrium level of real wages is $34 per hour, and the equilibrium quantity of labor is 90.

An increase in productivity reduces production cost due to which producer is encouraged to manufacture more commodities. To increase the output level, producers demand more labor in the market. As a result, the labor demand curve shifts rightward, as shown in the graph below:

LSLS, 40+ Real wage rate 35+ 34 30+ LD 25 LD 0 40 130 1201 80 160 200 Quantity of Labor

The demand curve's rightward shift increases the wage rate due to which people are encouraged to supply more labor to get more wages due to which the labor supply curve will shift rightward. Therefore, the new equilibrium point is e1, which implies the increase in the real wages and quantity of labor in the market.

At the new equilibrium point, the new equilibrium real wage level would be $35 per hour, and the new equilibrium quantity of labor would be 130.